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The $64 Trillion Question (Part 1)

How can we get the American economy to prosper again?

That we seem to have avoided another Great Depression doesn’t mean our economy is anywhere near as strong as it should be. In fact, most indicators—from unemployment to private investment—prove quite the opposite. What can be done? How can we ensure the U.S. enjoys not merely a modest recovery but the kind of buoyant prosperity we saw in the decades after World War II and briefly in the 1990s? We put the question to few political economists and will run their thoughts over the next couple weeks. Here is the first entry, from Clyde Prestowitz, a former Reagan administration official and the president of the Economic Strategy Institute.

The Obama administration justifiably takes credit for preventing a 1930s style economic collapse and engineering a modest recovery from the Great Recession. But, as Obama heads to Toronto Friday for the G-20 summit, the administration needs to ask itself whether that’s enough to lay “the foundations for a renewed American prosperity that is more sustainable, fairer for more of our citizens, and more competitive globally.”  

In the past, the United States has pursued prosperity in two distinct ways. Over the last three decades, it has embraced globalization and sought to act as the administrative, marketing, and financial center of world capitalism as well as the consumer of last resort for the export giants in Asia. This path has led to enormous excess consumption at the expense of investment and production and to large, chronic trade deficits.

Earlier in its history, the United States prospered by building and sustaining a wealth producing base that could manufacture goods and provide sophisticated services (like software and movies) that could be sold abroad in sufficient quantities to offset our consumption of imports. That model subordinated finance to production and consumption to investment. It also maintained a large, prosperous middle class and did not suffer from periodic financial crises.

In some of its pronouncements and actions, the Obama administration has suggested it is re-embracing this model. It has called for doubling exports, initiated a number of industry-specific programs like the promotion of green tech industries and bullet trains, and has appointed auto bailout adviser Ron Bloom to the newly created post of “manufacturing czar” to advocate for manufacturing within the policy process.

Yet, the administration seems ambivalent. These initiatives have not been carefully considered, and the commitment to them appears to be half-hearted. Moreover, some of the key factors necessary to renewing our prosperity have been overlooked altogether. Thus, on the present track, it’s unlikely that the administration will be able to follow through on creating the American renaissance it promised.

The administration has tagged for special development support certain industries that it believes will be able to compete globally and create lots of jobs while also serving important social and political ends. Particularly attractive among these have been the so-called green industries: They’re high tech. They’re the future. And they are an important part of our energy and environmental strategy.

So, the administration has allocated special funding for the development of wind farms and wind turbines, advanced batteries, solar cells, and bullet trains. Now, despite the mythology of American entrepreneurial and technological virtuosity, it is important to understand that Germany, Denmark, Japan, Korea, France, and China already have large government-funded programs to develop these same industries and are well ahead of the United States in all of them. Indeed, the Europeans and Japanese have had bullet trains for over 30 years. That’s why the administration’s support has been absolutely crucial to keeping existing U.S.-based operations viable and to attracting a few newcomers as well. But will the Obama team’s efforts be enough?

For starters, the administration has been hampered by bad planning. Take the case of wind farms. The administration has wanted to stimulate development of U.S.-based technology and production capacity for wind turbines as well as to stimulate construction of wind farms to deliver clean energy. In both areas, jobs would be created. But the program initially assumed that if the funding was made available to the farm operators, they would spend it on domestically-produced wind turbines.

That turned out to be a false assumption. A Texas wind farm promptly ordered its turbines from China. The ensuing public fuss led to some shift toward domestic sources, but the fact is that most of the wind-energy equipment being installed in the United States today is coming from Europe and Asia. Nor is the story different with regard to bullet trains and batteries. Some of the new battery plants being constructed with special stimulus money are really going to turn out to be factories for assembling imported Asian batteries. As for solar cells, even as Obama was putting up new money for their domestic development and production, Applied Materials, General Electric, and BP were moving their solar facilities and even in some cases their R&D to China.

Obama’s initiatives in other areas have fallen short for the same reason. The aircraft industry has traditionally been our single biggest exporter. It has relied on government support, and Obama has expanded that support as part of his program to double exports. But when Obama visited China last November, he promised that the United States would assist in the development of China’s new jetliner—promising, in effect, to fulfill China’s wish not to rely any more on importing planes from the United States. One can understand why China might want to have its own aircraft industry. But why was Obama agreeing to help?

Obama and Geithner have also pressured China to revalue its currency. That’s very important. China and most other Asian countries actively buy dollars in currency markets as a way of keeping the price of the dollar high relative to their own currencies. Economists generally agree that, as a result, the yuan and some other Asian currencies are valued 25 percent to 40 percent cheaper than they should be. This provides an indirect subsidy to their exports as well as an indirect tariff on imports from the United States. A 25 percent to 40 percent revaluation of the yuan, however, would cut the U.S. trade deficit by $100 to $150 billion and boost U.S. employment by as much as 2 million jobs.

Such “currency manipulation” violates the rules of the International Monetary Fund (IMF) and the World Trade Organization (WTO). Nobel prize winning economist Paul Krugman has called for a 25 percent surcharge on Chinese imports. But the Obama administration has followed the Bush administration in doing nothing except jawboning the Chinese. For a moment over the past weekend, it looked like the jawboning might have worked as the People’s Bank of China announced it would adopt a policy of greater currency flexibility. But on Monday, the bank maintained parity at the old rate. Any significant change is highly unlikely.

Finally, the administration has simply not addressed the most important causes of offshoring and outsourcing by American firms. Surprisingly, these are not labor costs, but tax and other financial incentives that foreign governments use to persuade companies to locate their factories and service facilities in their country.

Take what happened with Intel and Applied Materials, two of America and the world’s top high-tech companies that have recently announced construction of major production and R&D facilities in China. These companies did not move because of cheap Chinese labor. Semiconductor, solar-cell equipment, and computer chip production is not labor intensive, but rather capital and technology intensive. The United States has competitive operating costs in these fields, but China could offer financial incentives equivalent to a large portion of the total investment. Intel has explained publicly that these incentives can increase the profits of a plant by $100 million a year.

In the past, these two companies have been big exporters of high-tech products to China, but by dint of their moving production to China, their exports and the U.S. jobs linked to them could decline and certainly are unlikely to grow. To overcome this downward pressure on exports, the U.S. would have to ship more low-tech products such as the waste paper and scrap metal that are already among our two largest exports to China. That’s not a good solution.

What’s at issue in these cases is a clash between the outdated U.S. orthodoxy of international free markets and the new international reality of strategic globalization—between, on one hand, embracing free trade and eschewing subsidies, even when other countries do not, and, on the other hand, actively using government to promote jobs and trade. I witnessed the conflict at a White House meeting last year on how to revitalize the Midwest by turning old auto and auto-parts plants into green-tech factories.

At the meeting, one faction called for a comprehensive strategy of promoting R&D, matching foreign investment inducements, providing tax incentives for domestic production, and halting foreign-currency manipulation. The other group argued that markets always produce optimal results and that the future of green tech industries in America should be left up to market forces. The argument was never resolved, and it has not been resolved in the Obama administration.

But leaving things to the “free market” means allowing the Germans, Danes, Koreans, Japanese, French, and Chinese to dominate in the field. If the Obama administration wants to double exports—and better yet, double exports and reduce imports so that our overall trade balance improves—it is going to have to adopt its own strategy of strategic globalization.

What does that mean? At the G-20 meeting, the administration’s first step should be for the president to ask his colleagues to cooperate in bringing about a 25 percent to 40 percent revaluation of manipulated currencies in relation to the dollar within the next three years. The president should warn that if such an agreement cannot be reached, he will have no choice but to launch a full-scale effort in the IMF, WTO, and elsewhere to halt the mercantilist manipulation of currencies. He should leave no doubt that he will do whatever is necessary, including even taxing certain capital inflows, to achieve substantial currency adjustments.

The administration should also call for negotiating restraints on the investment incentives other countries employ to attract foreign companies. At the same time, however, it should create a fund with which to match the offers of others. The president and his top officials should also preach “Invest in America.” No foreign business leader should come to America without hearing how important it is to consider investing in America. No American business leader should escape hearing the same message. The Secretary of Commerce should develop an Invest in America office modeled after Singapore’s Economic Development Board.

To further encourage investment, the administration should propose reducing the corporate tax rate, which next to Japan’s is the world’s highest, to 15 percent on profits on new investment in tradeable goods and services. And the president should emphasize that to compete globally, America needs the most modern infrastructure. The administration should establish a “Rebuild America’s Infrastructure” program with an Infrastructure Bank at its core. The Manufacturing Czar should be converted into a Competitiveness Czar. The czar should identify industries in which America could compete and should propose measures, including tax incentives and government orders, to ensure these industries can do so.

There are other measures that could also be taken, but they are probably too much for Congress to swallow right now. For instance, Europe uses its value-added tax not only to raise revenues but also to promote exports. The tax is rebated on exports while it is added onto the price of imports. The U.S. could replace the Social Security tax partially or entirely with a value-added tax. That would prevent over-consumption, increase saving, promote exports, and solve the long-term problem of financing Social Security. It probably won’t happen, but the other measures I have suggested could be implemented. And if the Obama administration were to adopt them, it would recreate full employment and put the country back on a path of sustainable prosperity with, once again, a thriving middle class.                                                  

Clyde Prestowitz is the author of the The Betrayal of American Prosperity. He was Counselor to the Secretary of Commerce in the Reagan Administration and was Vice Chairman of President Clinton’s Commission on Trade and Investment in the Asia-Pacific Region. He is now President of the Economic Strategy Institute.

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